performance history, net of fees

How exactly does a fund or adviser provide monthly performance data "NET OF FEES", when fees are charged quarterly? All funds are required to provide this data in a monthly and YTD format, yet the industry standard seems to be quarterly performance fees.

Assume a 20% quarterly performance fee and no administrative fees.

Example Returns
Jan +2%
Feb +10%
Mar +5%

So +17.81% for the quarter before fees and 14.25% after fees. Which of the following monthly reports is correct, net of fees?

#1
Jan +2%
Feb +10%
Mar +1.82%

or

#2
Jan +0.81%
Feb +8.81%
Mar +3.81%

or

#3
Jan +1.614%
Feb +8.07%
Mar +4.035%

In #1 the fees are applied only to the final month, which I'm certain isn't correct. #2 the fees are divided evenly across each month, which is inaccurate but could be correct. And #3 is the most accurate and is essentially creating a compound monthly growth rate so that when compounded the three numbers would equal the realized return.

Third is correct, although not sure about your math. You seem to have some extra decimals hanging off the end.

Your incentive allocation shows up as a fee each month (or reversal of fee in down month). Final amount is crystallized quarterly.

What always confused me (until my admin set me straight) is that your fees, subtracted each month, are no longer in the funds equity the following month... It's literally a fee, like if you had paid some other service provider. After end of quarter, you as GP can choose to reinvest that amount... At which point it goes back into equity.

Third is correct, although not sure about your math. You seem to have some extra decimals hanging off the end.

Your incentive allocation shows up as a fee each month (or reversal of fee in down month). Final amount is crystallized quarterly.

What always confused me (until my admin set me straight) is that your fees, subtracted each month, are no longer in the funds equity the following month... It's literally a fee, like if you had paid some other service provider. After end of quarter, you as GP can choose to reinvest that amount... At which point it goes back into equity.

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Thanks.

So basically, you determine what the quarterly gain would be, net of fees, and then determine the proportionate compound monthly growth rate that would realize that quarterly gain.

Uh, you misread what I wrote.... you subtract your fees on monthly basis. Ie, claim 20% every month. It's just not crystallized and removed into your GP account until end of quarter.

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Ahhh...

The only question I have with that is that accruing the fee, but not removing the capital changes the actual realized returns. Effectively lowering them with each passing month until the funds are actually removed. Am I missing something?

The only question I have with that is that accruing the fee, but not removing the capital changes the actual realized returns. Effectively lowering them with each passing month until the funds are actually removed. Am I missing something?

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Sorry Heech, it appears that I had selective reading on your last post too and you effectively answered the above question already. According to your earlier post, the accrued fees are actually removed from equity, thus avoiding the situation that I was referring to. That is very interesting and isn't the assumption that I would've made.

To be clear for anyone else reading this, I am talking about a CTA. When he talks about "incentive allocations", Heech is specifically referring to a CPO or some other 'Pooled' structure. CTAs cannot charge incentive allocation, but instead charge fees. It seems like minor semantics, but it is very different in the tax world. Specifically, Heech can receive preferential tax treatment by simply reallocating a greater portion of the pool's profits to his account, thus avoiding the classification of "income". A CTA cannot do this, as there is no pool. All fees paid to the CTA are considered income and taxed at income rates. Very unfortunate for those of us choosing not to go with the CPO structure. Consequently I find myself paying about 12% higher tax than my CPO counterpart. Interesting that the government punishes you for running a more transparent structure.

Interesting point. Are CTA fees taxed as regular income? Not even 60/40 treatment?

You are correct though that CPO fees are taxed according to nature of underlying income, so 60/40 treatment.

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Yes, there is no pool to be a member of. As the GP in your fund, you don't have to charge a fee to get paid. You simply procure a disproportionately large amount of the profits. Those are considered capital gains to you as an individual and qualify for 60/40 tax.

In a CTA, since each account remains completely separate, there is no way for me to simply reallocate profits. In order to get paid there must be an actual withdrawal of capital and payment in the form of a fee. All "fees" are considered normal income and subject to tax as business income. I only get 60/40 on my own personal trading.

Don't get me wrong, I'm not against CPOs, and there were many factors involved in deciding to go the CTA route instead. But... the vast majority of fraud cases involve CPOs rather than CTAs, which is why the regulations are a bit more stringent for them. IMO, the government should be encouraging managers to choose the more transparent structure that is less prone to fraud. Instead, they do the complete opposite. Very typical of our government.

Yes, there is no pool to be a member of. As the GP in your fund, you don't have to charge a fee to get paid. You simply procure a disproportionately large amount of the profits. Those are considered capital gains to you as an individual and qualify for 60/40 tax.

In a CTA, since each account remains completely separate, there is no way for me to simply reallocate profits. In order to get paid there must be an actual withdrawal of capital and payment in the form of a fee. All "fees" are considered normal income and subject to tax as business income. I only get 60/40 on my own personal trading.

Don't get me wrong, I'm not against CPOs, and there were many factors involved in deciding to go the CTA route instead. But... the vast majority of fraud cases involve CPOs rather than CTAs, which is why the regulations are a bit more stringent for them. IMO, the government should be encouraging managers to choose the more transparent structure that is less prone to fraud. Instead, they do the complete opposite. Very typical of our government.

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A CPO is just a hedge fund for futures/FX instead of equities. Basic LP with a GP. Plus, many CPO's have a third party admin to oversee the funds for added confidence. Heck, the biggest fraud of all time (Madoff) was a bunch of individual accounts (CTA style).

Heech, so when it comes to tax filing time, your income is not reported as income, but capital gains? Also, I assume if you re-invested your "fee's" back into the LP, you still pay the 60/40 on it?

And yes, re-investment of fees doesn't affect tax status. Note that because futures are always marked to market anyways... this is different from the private equity (and other hedge fund) world, where carried interest is really a HUGE tax advantage.